Why aren’t building owners scaling efficiency? It’s not just a lack of capital.

Efficiency advocates, ourselves included, believe that efficiency will benefit building owners. We believe this because we see a large amount of monetary and ‘soft’ value created by efficiency measures.

We have heard many times, and have often thought ourselves, that if there was just a mechanism to provide cheap capital, building owners would pursue the opportunity to retrofit their buildings.

This assumes a set of building owners is out there who are actively interested in retrofitting their buildings, but whose only barrier is access to capital.

But is that really true?

Let’s unpack the argument.

The logic makes fundamental sense. If energy efficiency is beneficial to building owners, and if the market can provide cheap loan capital, owners would use this capital to invest in energy efficiency measures at low cost. Owners wouldn’t have to pay significant sums out of pocket for the retrofit, the incremental cash flows would cover the debt service, and the project’s equity owner would maintain any upside of additional value that flows from the energy efficiency retrofit.

So does this type of building owner really exist?

You can split the world of building owners along two lines – those who have relatively strong access to capital and those who don’t. Those with access to capital are the Vornado’s of the world. These guys don’t need energy efficiency loans. They can self fund. (Now that doesn’t explain why they’re not doing retrofits en masse, but it indicates that capital is not the only barrier.)

The other type is the owner without ready access to capital. This could be because their buildings are fully-levered or over-levered or it could be that the property is struggling and can’t take on additional debt financing. For many commercial buildings, their mortgages contain covenants preventing additional debt from being assumed without first mortgage holder approval.  Spending incremental capital on energy efficiency is a barrier for this class of owners.

So now let’s introduce our cheap loan financing. What happens now? The building owners without previous access to capital will start doing efficiency en masse right?

Of course, if access to capital really is the only barrier, then great. Solving this problem is not trivial. For example, the energy efficiency community is still dealing with questions of how to achieve collateral and security interest in a retrofit project, issues of payment guarantees vs. performance risks, and the challenge of how to aggregate sufficient projects to meet thresholds for existing lenders. We are confident however, that with so many smart organizations (Carbon War Room, Clinton Climate Initiative, Hannon Armstrong, DOE, Serious Materials, and many other fantastic forward thinking organizations) working on this, someone will figure out how to make cheap loan capital work for retrofits.But what if capital is not the only barrier? After all, if we look at the well-capitalized part of the market, we don’t see deep retrofits happening all that much more frequently, which is one of the reasons that makes us believe capital isn’t the only thing holding retrofits back.

To further bolster this point, we suspect easy access to cheap capital is highly correlated with the class of the building – so most of those buildings with easy access to capital are the Class A buildings, while it is the Class B and C buildings that have less access to capital. Our hypothesis is that Class A tenants also care more about occupying energy efficient buildings. If that’s true, then building owners that lack access to capital are currently less likely to retrofit than those owners with easy access to capital, even after normalizing for access to capital.

Much of the energy efficiency community focuses near exclusively on access to capital issues, ourselves included (the name of the blog as Exhibit A).  This thought experiment indicates the need to expand our focus to the other potential levers we can pull to scale efficiency.


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